San Miguel Corporation

San Miguel Corporation Should a Beer Company be a Public Utility Provider?

SUBMITTED TO: Prof. Lilian Litonjua

SUBMITTED BY: Camacho, Cariza Lizyl Ludovice, Ma. Raiza Luna, Ivan Sale, Jude-Allein

ABSTRACT San Miguel, the largest beverage and food company in the Philippines has decided to spin off its popular and profitable domestic beer business and begin to invest in power generation and other infrastructure industries. Some have questioned the wisdom of such a radical departure from its core competencies and the desirability of the company in providing public utilities. The case explores the issues of strategy diversification and privatization. INTRODUCTION One of the most popular and well-known brands of beer in the Philippines and throughout Southeast Asia, San Miguel, has been brewing beer for well over one hundred years. The company’s brewing business produces such well-known and popular brands as San Miguel Pale and Red Horse. The company also owns Ginebra San Miguel distillers, San Miguel Pure Foods, and San Miguel Packaging. The company has a vertically integrated structure in the food and agriculture industry, ranging from breeding, to canning, to retail branding. Recently shareholders approved a plan to spin off its domestic beer operations and to diversify into un related business areas. The spin off of the beer business (the historical core of the company) will provide capital to invest in new businesses, including the purchase of public electricity generating assets which are being considered for sale by the government of the Philippines. Questions have arisen as to whether this form of diversification is a wise strategic move for the company and if privatization of electrical services is good for the Philippines. SAN MIGUEL CORPORATION San Miguel Corporation began as La Fabrica de Cerveza de San Miguel in 1890, operating in Manila under a royal charter from Spain. The company incorporated in 1913, and in the 1960s changed its name to San Miguel Corporation (SMC). Early in the company’s existence it began a process of backwards vertical integration in which it acquired barley fields and later expanded into other agricultural products. The company eventually expanded into soft drinks, spirits, and packaging operations. San Miguel has the distinction of being the first foreign bottler of CocaCola, acquiring the franchise in 1927. Today the company is the largest food and beverage business in the Philippines, as well as all of Southeast Asia. The company operates over 100 facilities in the Philippines,Southeast Asia, China, and Australia. San Miguel Corporation (SMC) earns most of its revenue in the Philippines, and most of its revenue is generated in its food and beverage industries.

FIGURE 1 Sales by Country 2006 Philippines 63% Australia 30% China 3% Indonesia 1% Vietnam 1% All other 2% FIGURE 2 Sales by Division 2006 National Foods 27% Alcoholic beverages 26% Food and agriculture 25% Soft drinks 15% Packaging 7% San Miguel controls over 90% of the beer market in the Philippines, over 85% of the soft drink market, and significant shares of the processed meat and poultry markets. The core values of SMC are stated by the company as: Passion for Success; Teamwork; Respect for Our People; Customer Focus; Innovativeness; Integrity; and Social Responsibility. The decision to move into traditional public works is innovative; however, the company’s past has not been free of controversy, and there have been questions of conflict of interest and integrity issues. The government of the Philippines owns a significant stake in the company due to seizure of assets deemed taken from the people of the Philippines during the Marcos era. One of San Miguel’s owners fled the country with Ferdinand Marcos (but later returned to the Philippines) after the “people’s revolution” in 1986. The company has been known as a fierce competitor and has in the past been accused of using unethical practices to thwart its competitors. The recent decision to rid itself of its domestic beer business has caused concern among investors. The company’s share price, as traded as an American Depositary Receipt (ADR) has fallen (Figure 3), despite recent gains in profitability. Concerns over the ability of the company to diversify into unrelated businesses may be a contributing factor to the stock’s decline. Even though SMC will maintain ownership of San Miguel brands and properties, and receive rents and royalties, spinning off the core enterprise in favor of unrelated diversification has worried some investors.

FIGURE 3 San Miguel Corporation Share Price 1 Year Chart

San Miguel Corporation Share Price 1 Year Chart Source: CNN/Money Standard & Poor’s and Moody’s has placed San Miguel’s credit rating under review, indicating the uncertainty of the strategic move. San Miguel’s domestic beer sales have been showing slow but steady growth and increased earnings. In July 2007, shareholders approved the spin-off of the domestic brewery division and the investment of up to 35B pesos, or approximately $775M, in new business ventures. Domestic beer sales are not expected to increase significantly and the company wants to invest in more growth-oriented industries. As company chairman, Eduardo Cojuangco states, “We want to be in industries that have scale and will grow, and we are determined to build leadership positions in key areas where important trends are driving future growth, not just for San Miguel but for the Philippines too.” San Miguel is partnering with a Malaysian and American company to bid for control of the Philippines’ power grid. The demand for electricity in the Philippines is expected to continue to grow, and forecasts show that current supply will soon be insufficient to meet public demand. The company also has plans to invest in mining, water, and other public sector businesses.

Managers of San Miguel feel that the company can capitalize on the proposed privatization of electrical services in the Philippines. Many of the power generating facilities in the Philippines are twenty-five years old or older, and supply isn’t always dependable.Some feel that the government-owned service is poorly managed and traditionally has operated as a drain on the Filipino government budget. However, recent rate increases and efficiency moves have improved the financial performance of the public utility. PRIVATIZATION The question of state ownership over private ownership has been debated by economists and others for a number of years. A more libertarian view is that all industries should be placed in private hands, with the possible exception of cases that involve market failure, where markets are not able to function effectively. Such a case is sometimes made for some utilities and public goods such as defense, public justice, and roads (with the exception of toll roads for long stretches of highways.) Issues raised to support the privatization of industry generally involve efficiency, customer satisfaction, bureaucracy, corruption, accountability, and lack of market discipline. Proponents of privatization argue that private ownership is generally more efficient than government ownership. They claim that private businesses are more competitive and must continually strive to reduce costs and ensure customer satisfaction. They propose that government ownership creates bloated, bureaucratic organizational structures. Also proposed is the belief that concerns for customer satisfactions are not as strong with government enterprises. Proponents of privatization also argue that public ownership is more prone to corruption and lacks transparency and accountability. Private companies, they argue, must be accountable to shareholders. The basic argument is that the lack of market discipline imposed by a competitive marketplace produces underperforming organizations. Those who feel government has a role to play in ownership point out that many of the proposed advantages of private ownership are not realized. Corruption and lack of accountability can be found in private enterprises, and the excessive salaries paid to some top managers are seldom challenged by directors or shareholders. Opponents of privatization also feel that some public goods are essential, and, when placed in private hands, can lead to harmful increases in market prices. Particularly in cases where private firms have a monopoly position, the ability to charge “what the market will bear” could harm the least advantaged members of a society. Proponents of public ownership also argue that politicians are accountable to votes, perhaps even to a greater degree than managers are to their shareholders. They argue that there are alternatives to complete privatization such as partial ownership, with government still maintaining some control, or localizing the public good to a lower level of government, such as a state or city, in order to reduce bureaucracy and increase customer satisfaction. With approval of the sale of the domestic brewing division, San Miguel is looking for a buyer and confident that its capital and managerial skills can find better utilization in new and diverse industries. Some feel that a company that claims innovation as a core value should not cling to its past, and that seeking growth opportunity in diverse industries is a good strategic move. Others argue that such a radical change in corporate strategy is very risky, and a company with a checkered past should not be in charge of providing basic public services.